Knowing The Importance Of Buy Term And Invest The Difference

I am sure that some of us has heard of the saying “Buy term, invest the difference” when buying insurance and investment products. However do we really understand what this means? So why do most financial planners recommend that we should “buy term and invest the difference” while some insurance agents keep on bugging you to get their recommended product ?

Most financial planners would tell us to stay away from whole life insurance products as they are considered rip offs. These kinds of products are not so popular anymore in the United States. In order to fully understand “whole life” versus “term” they are differentiated as follows: Term insurance refers to life coverage only while “whole life” refers to term policy with an investment scheme. Insurance agents usually present whole life insurance as something that will help you save for your retirement. Forcing you to save is probably something that is good for you, however the bad thing about this is that the returns for the investment in whole life insurance is very low. It is a pity that these type of products are still sold in the Philippines. Sadly, people still buy them because of inadequacy of financial knowledge.

To fully understand this, let me give you an example. The other week, my mom asked me if she should continue paying a certain type of insurance product that she bought for my sister. It was worth about P 400,000.00 (Philippine Peso) the balance left is P 200,000.00 as she has already paid half of it.

I asked her what the benefits of the insurance product were. She said that after 20 years, my sister who is still 18 years old will receive P 40,000.00 per year until she reaches the age of 65. At the age of 65 she can choose to receive P400,000.00 lump sum. If she chooses not to receive the P 400,000.00 lump sum, she can choose to continue receiving P 40,000.00 for the rest of her life. Plus she is also insured for two million pesos for the rest of her life.

To evaluate whether or not she should continue paying the P200,000.00 we will evaluate the benefits of the insurance product versus the “Buy term, invest the difference” option.

If you add the total money that my sister will be receiving, she will get a total of P1,520,000.00 at age 65, that is if she opts to get the lump sum at age 65, plus she is insured for two million pesos.

On the other hand, if we follow the buy term invest the difference scheme, if her insurance company will allow her, she will convert what she has already paid into “term insurance” which usually runs for only 20 years and then invest the P 200,000.00. If she will invest the P 200,000.00 at a vehicle of investment that gives about 10 % return per annum and also re-invest the returns of the investment taking full advantage of compounded interest at age 65 she will get a whooping P 17,639,497.05.

Can you see the big difference? What is P 1,500,000.00 plus P2,000,000.00 insurance vs. P 17,000,000.00+.

You might ask what about insurance protection? Take note that pure term insurance is very cheap. She can just buy term insurance and renew it every 20 years.

You might be wondering what investment vehicle would give you 10 % return per annum? There are several of them out there. You can invest in mutual funds where returns can run from 10 % to 70 % or more. However these returns are not guaranteed but historically the rate of return does not fall below 10 % per annum. (that is if they are invested in equities) You can also invest in the stock market. In the Philippines, a bullish stock market gives a high rate of return that even the most conservative investors in the stock market earns more than 10 % per annum.

Now you know why buying term and investing the difference does makes sense !!!

Would you like to know more about investment strategies ? Visit the blog of Zigfred Diaz where he blogs about several interesting topics such as investments, money management, business, making money online and Stock market investing